03 January 2011

New deterioration in the US savings rate and its implications

The revised 3rd quarter 2010 US GDP figures show a downturn in the percentage of domestic savings in US GDP – see Figure 1. This shift is small, from 11.8% to 11.7% of GDP, but the trend is highly significant.

Figure 1

Figure 1 confirms the continuation of the long term downward trend of US savings, with inevitable oscillations in business cycles, since 1981. Each cyclical savings peak was lower than previous one – 21.4% of GDP in 1981, 19.0% in 1998, and 16.4% in 2006. Each cyclical trough was also lower than the one before – 14.2% in 1992, 13.6% in 2003, 10.2% in 2009.

A small cyclical recovery in US saving took place, from the 10.2% of GDP trough in the 3rd quarter of 2009 until the second quarter of 2010 at 11.8%, and it is this which stalled in the 3rd quarter of 2010.

Even more striking is that the 3rd quarter of 2010 is the 10th consecutive three month period in which US net domestic savings, i.e. gross domestic savings minus capital consumption, has been negative – as shown in Figure 2. The last time US net savings were negative was during the Great Depression in 1931-34 - see Figure 3.

Figure 2

Figure 3

To put it in deliberately provocative, but accurate, language this means that the world’s number 1 capitalist economy has for the last 10 quarters not produced net capital – US capital creation is less than US capital consumption.

The implications of this new drop in the US savings rate, particular if maintained in coming quarters, are numerous. Two interlinked ones, with major implications for US economic performance, immediately stand out.

First, the core of the US Great Recession is a severe fall in fixed investment. Rapid US growth cannot take place without a sharp recovery in fixed investment - which in turn must be financed by savings. If US domestic savings remain depressed, then either US fixed investment will remain low, which implies a slow US upturn, or the US must finance a new higher level of investment from abroad – i.e. there must be a new widening of the US balance of payments deficit.

Second, one of the major theories of the international financial crisis, outlined most influentially by Martin Wolf, chief economics commentator of the Financial Times, was that it would lead to an overcoming of "global imbalances", that is the balance of payments deficit of the US and the surplus of China and other states, through an increase in US saving.

As the US balance of payments deficit, by accounting identity, is equal to the US shortfall of domestic savings compared to domestic investment, the US balance of payments deficit could decrease through either, or both, an increase in savings or a decline in investment. But, as shown above, US savings have stalled, and partially reversed, as a percentage of GDP at a historically low level. The improvement in the US balance of payments since the beginning of the international financial crisis is primarily due to a fall in fixed investment, not to a rise in savings. An analysis that international financial imbalances would be corrected via a rise in US savings has not been been factually confirmed.

These two issues are evidently interrelated. A major rise in US savings, which would permit an increase in US fixed investment simultaneously with a narrowing of the US balance of payments deficit, would provide the basis for relatively rapid US economic growth. The current factual trend, that of a continuing low level of US savings, does not permit rapid US growth except in conditions of worsening of the US balance of payments deficit.

The current trend of US savings therefore continues to point to relatively slow US growth unless the US is prepared to permit a significant deterioration of its balance of payments position - i.e. a new, and in the long term, unsustainable worsening of global imbalances. Short term fluctuations in US growth must therefore be judged against this strategic background.